Implementation of Title VII of the Dodd-Frank financial reform, entitled the “Wall Street Transparency and Accountability Act of 2010” (the “Act”), requires numerous rulemakings by the Commodity Futures Trading Commission (“CFTC”) and Securities Exchange Commission (“SEC” and, together with the CFTC, the “Commissions”). The Act is generally intended to bring the $615 trillion over-the-counter (“OTC”) derivatives market under greater regulation by increasing pricing transparency and taking steps to reduce systemic risk. Among other things, the Act encourages and, in some cases, requires many derivatives to be traded on registered exchanges and cleared through registered central counterparties and imposes margin and capital requirements on such contracts. Generally, the CFTC and SEC have until July 16, 2011 (or 360 days from July 21, 2010, the date the Act was signed into law) to promulgate the rulemakings necessary to implement the Act.
One of the first significant steps taken by the Commissions was to publish an “Advance Joint Notice of Proposed Rulemaking; request for comments” (the “Interagency Request”) on August 20th. The Interagency Request asked for public comment on certain “key definitions” of the Act which the Commissions, in consultation with the Federal Reserve, are required to further define. The ultimate scope of these key definitions will, to a large extent, define the scope of the Act itself. One significant example of this is the definition of “major swap participant,” which will determine which end users and other non-dealers will be subject to the rigorous registration, reporting, minimum capital and margin, recordkeeping and other requirements of the Act. The comment period lasted for thirty days.
On October 1st, the CFTC also published for public comment a “Proposal to Mitigate Potential Conflicts of Interest in the Operation of Derivatives Clearing Organizations, Designated Contract Markets, and Swap Execution Facilities” (the “Proposed Conflicts Rules”). The CFTC identified several potential conflicts of interest in the operation of the derivatives clearing organizations (“DCOs”) with which most swaps will have to be cleared and designated contract markets (“DCMs”) and swap execution facilities (“SEFs”) on which most swaps will have to be traded. These potential conflicts of interest include, for DCOs, the determination of (i) whether a particular swap is capable of being cleared, (ii) the minimum criteria that an entity must meet to become a clearing member and (iii) whether a particular entity satisfies that criteria and, for DCMs and SEFs, balancing the advancement of commercial interests and fulfilling self-regulatory responsibilities. The Proposed Conflicts Rules attempt to mitigate these potential conflicts of interest through the imposition of structural governance requirements and limits on the ownership of voting equity (and exercise of voting power) in the relevant entities.
In particular, the Proposed Conflicts Rules would impose specific composition requirements on the boards of directors of each DCO, DCM and SEF and would require that such entities have a nominating committee and one or more disciplinary panels. Further, each DCO would be required to have a risk management committee and each DCM and SEF would be required to have a regulatory oversight committee and a membership or participation committee. Moreover, the Proposed Conflicts Rules would impose (i) a twenty percent (20%) cap on voting power by individual members of DCOs, DCMs and SEFs and (ii) a forty percent (40%) cap on the collective ownership of DCOs by the following “enumerated entities”: bank holding companies with over $50,000,000,000 in total consolidated assets, or any affiliate; nonbank financial companies, or any affiliate, supervised by the Federal Reserve; and swap dealers and major swap participants (each as defined in the Act and further defined by the Commissions). The Proposed Conflicts Rules do not, however, place any restriction on the ownership of non-voting equity in DCOs, DCMs and SEFs.
Support for the proposed limits was not unanimous among the CFTC Commissioners. In particular, Commissioner Jill E. Sommers dissented, stating her “grave concerns that the proposed limitations on voting equity, especially those proposed for enumerated entities in the aggregate with respect to DCOs, may stifle competition by preventing new DCMs, DCOs and SEFs that trade or clear swaps from being formed.”
We will continue to monitor and report on significant developments in the implementation of the Act.
 The Proposed Conflicts Rules also provide for an alternative ownership limit for DCOs, i.e., that no aggregate limits apply if no single member or enumerated entity has more than five percent (5%) voting control. The CFTC acknowledged that these ownership limits may not be appropriate for all DCOs and proposes a procedure for exemptions.